Nov 20, 2023 - Economy

Central banking tortoises vs. hares

Illustration of a running track resembling Earth with shapes of continents printed on the rubber

Illustration: Annelise Capossela/Axios

If you are in charge of setting interest rates for a major economy, aiming for low inflation and ample jobs, what's the best tack: Should you adjust rates quickly or gradually?

Why it matters: That is the choice the world's leading central banks faced in 2022 as high inflation took root. Their different choices  — and results — could shed light on which strategy is best in the future.

  • At a Boston Fed conference Friday, former Bank of England official Kristin Forbes laid out the relative trade-offs of central banks that acted as tortoises and those that were hares in the monetary tightening cycle of the last two years.

Flashback: Some central banks (the tortoises) largely held to the past pattern of moving slowly and relying on small, quarter percentage point rate hikes; meanwhile, the hares ripped up the playbook quickly, and hiked rates 0.75 percentage points or more at a time.

  • The tortoises included the Bank of England and the central banks of New Zealand and Norway. The hares include the U.S. Federal Reserve, the European Central Bank, and the central banks of Sweden, Australia and Canada.

What they're saying: "Each of these strategies does have some important advantages and disadvantages," said Forbes, an economist at MIT.

  • With a tortoise strategy, she said, you can "tighten a little, see how it's affecting the labor market, see how that's feeding through into inflation and then see if you need to do more."
  • "Also by moving more slowly in the tortoise strategy, that allows entities to adjust and reduces the risk that something breaks," she said.
  • "Households have more time to plan ahead. Companies have more time to plan ahead and financial institutions have more time to plan ahead if you move more slowly."

Yes, but: "The tortoises also took longer to get where they already thought they needed to be," Forbes said. By contrast, the hares' more aggressive action may have helped strengthen the central banks' credibility, and thus made it less likely that inflation become entrenched.

  • "By tackling inflation more aggressively … you're less likely to see changes in the economy that could make inflation stickier. For example, you're less likely to see people build inflation indexation into contracts," she said.
  • That means in the hare approach you might end up doing less tightening overall, "and then you might actually have less impact on unemployment in the labor market."

The big picture: Forbes then compared the economic results of the tortoises and hares, and found the hares have achieved both bigger reductions in inflation and less labor market pain.

  • She acknowledges many caveats. This is more a simple back-of-envelope exercise rather than a rigorous model, though Forbes said a more sophisticated version of the analysis — accounting for many more variables — is in the works.

The bottom line: So far, at least, the central banks that have moved fast have gotten better results for their economies than those that took it slow. Whether that has broader lessons for the future is still an open question, however.

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